Why SPACs Could Leave Investors in the Cold

The misalignments are stark.

SPAC sponsors say they are putting their reputations on the line, especially if they plan to repeat the process. This is the case for serial sponsors like the tech investor Chamath Palihapitiya, the veteran banker Michael Klein and the buyout specialist Alec Gores. In some cases, sponsors invest some of their own money in the company they are acquiring, better aligning their interests. But remember that they have often already been given 20 percent of the business, so they are playing partly with house money.

SPAC sponsors also try to get established, name-brand investors on board for their launch, which conveys legitimacy to the empty shell. But for some of these investors, it is simply about financial engineering. They have no unique interest in a SPAC, because they have the option to redeem their investments, plus interest, for a modest but predictable return almost no matter what happens with the acquisition. If the deal proves to be a big winner, it’s a bonus.

Uniquely, the sponsor does not have a fiduciary duty to the investors in the acquired company. Very few sponsors seek so-called fairness opinions from third parties to validate the price they are paying for an acquisition. And while mainstream investors increasingly pump extra funds into SPACs at the time of a merger, they typically do so at a lower price than less connected investors.

SPACs try to differentiate themselves by promoting the experience of their managers and relationships with companies that they may acquire. But the sponsor must use the money raised in a SPAC within two years, in most cases, or be forced to return it. That provides an incentive to get a deal done, rather than get the right deal done at the right price and time.

There are more than 300 SPACs with some $100 billion in cash currently seeking acquisitions, according to the data service SPAC Research. Since SPACs typically buy companies five times their size, thanks to outside investments, that implies something like $500 billion in potential buying power.

“We have a massive demand-supply imbalance problem coming. It’s inevitable,” Mr. Kawaja said. “We know how it’s going to end.”

None of this is to say the traditional I.P.O. process is better than the SPAC process. Both have benefits and drawbacks. It is possible that SPACs will become a routine way for certain types of companies to go public.

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